Are Central Banks Out of Options?

The Central Bank interventions of the last five years can be broken into two categories: actual monetary policy changes and verbal interventions.

The period from 2009-2012 largely saw Central Banks engaging in the former. The only problem is that two primary monetary policies in Central Banks arsenals (cutting interest rates, launching QE programs) are either useless in combating solvency issues or have little to no effect in terms of generating growth.

Regarding the first issue, if you are insolvent as most of the large banks in the world are, the ability to borrow more money at lower interest rates is of next to no value. If you’re leveraged at 26 to 1 or higher, borrowing more money accomplishes nothing when your equity is wiped out by a 4% drop in asset prices.

Regarding the second issue (QE’s failure to generate growth), consider that both Japan and the UK have engaged in QE policies equal to or greater than 25% of their respective GDPs and have failed to generate a significant uptick in their GDPs or employment.

Moreover, the positive aspect of QE, the alleged “wealth effect” or the belief that individuals would spend more money based on higher asset prices, can quickly become a political issue as it is largely the top 1% of individuals who benefit most from this.

As a result of this, beginning in 2012 Central Banks began to move towards using verbal intervention more than monetary policy. After all, if you can get the positive benefit of QE (higher stock prices) without actually having to do anything from a monetary perspective… why engage in QE at all?

The Fed bucked the trend in 2012, launching QE 3 and QE 4 to boost Obama’s reelection chances. Since that time, every positive move the Fed has made has been verbal in nature (promising to maintain low interest rates, etc.). In terms of monetary moves, since that time Fed has been actively tapering QE.

However, we may be reaching the end of efficacy even for verbal intervention. Consider that Mario Draghi managed to kick off a two year rally in stocks and two year drop in bond yields in Europe simply by promising to “do whatever it takes” in mid-2012.

The ECB didn’t implement any new monetary policies until June 2014 when it cut interest rates to negative. Since that time, EU markets have largely sold off. And when Draghi mentioned that the ECB was “considering QE” in yesterday’s press conference, the intraday rally was short-lived. In simple terms, the markets want Draghi to act again, not simply engage in verbal intervention.

So, globally interest rates are at ZERO or even negative and the markets have realized that QE doesn’t do much. What exactly does this leave for Central Banks to do?